11/08/2010 @ 5:45PM

How Will The Election Results Affect Your Portfolio?

Last Tuesday’s historic elections have many people asking, “What does a Republican House mean for the markets–and my portfolio?” The interplay between politics and financial markets has been a major topic of discussion over the last few years, against the backdrop of major government interventions in the financial sector and other sectors of the economy. Certainly these developments will affect all investors’ long-term financial situations. However, historical data shows that any impact political party changes in elections have had on short-term market returns have proven to be marginal, unpredictable, and not very statistically significant.

Take, for example the basic correlation (where a correlation of 1 represents perfect agreement and a value of 0 represents no correlation at all) between which party controls the House of Representatives and the return of the S&P 500 in a given year going back to 1926. We find S&P 500 returns are essentially uncorrelated to equity market returns, with a correlation of 0.008.

For context, this means election results are almost exactly 10 times less correlated to the S&P 500 than are five-year Treasury Bonds. If Congressional majorities were an investable asset, we would likely be looking to use them as a diversifying alternative asset class!

When we break down the data further, we continue to find little that is statistically significant. For example, the S&P 500 has had positive returns 73% of the years in which Democrats controlled the House, vs. 68.2% of the years Republicans held the majority. The market as a whole had positive returns in 71.8% of the calendar years back to 1926, meaning the positive return percentage differences for each party represent only 1 or 2 years out of the decades each party has controlled the lower house of Congress. Likewise, the average return in “Democratic” years is 11.9%, while the mean in “Republican” House years is 11.5%–certainly not a statistically significant difference.

Interestingly, while majority parties in both the house of Representatives and the Senate didn’t seem to have much impact on equity market returns, on average, the party affiliation of the President did: the mean return of the stock market during years with a Democratic president averaged 15.1%, while with Republican presidents, it averaged only 8.6%. Yet separating policy impact from all of the other factors that affect market returns is exceedingly difficult (perhaps impossible). Ultimately, this is the challenge in trying to time the market based on election results: Who can say whether the bull market that started in the 1990s was due to Bill Clinton’s Democratic policies, Congress being under Republican control, economic factors outside of political influence, or–more likely–a combination of all of these factors (and many more)?

Looking at periods in which the same party controlled both the White House and House of Representatives, the average return was of 12.9%, vs. an overall mean of 11.8%. Not much of a difference.

Likewise, since 1926, Congress has changed party majorities seven times, with positive market returns in five of the seven subsequent years (roughly 71% of the time), but the market itself is positive 71% of the time. Again, it would seem to be impossible to draw a statistically significant conclusion from these results.

Is it possible, then, that the impact of an election is already priced into the market prior to the election results? In fact, the market has exactly the same “batting average” of positive annual returns for the election years prior to a party shift as for the years following a new majority–5 out of 7, or 71%.

In short, election results are indeed a factor in market return–significant, yes, but ultimately all but impossible to separate from every other economic, corporate, fundamental, global or psychological factor that influences the price of equities over the short run.

The only conclusion we can safely draw from all of this is that our energy is better focused on keeping a close eye on where fiscal and economic policies go from here when the new members of Congress take their seats. And there is no shortage of other meaningful market news for investors to chew on in the meantime: for example, the announcement on Wednesday that the Fed would pump an additional $600 billion into the economy through additional rounds of U.S. Treasury bond purchases sent equity markets soaring Thursday. While this move may indeed tip the economy toward higher growth, it will also push most bond prices up, lowering their yields. Lower yields makes borrowing more attractive, and while more borrowing ought to lead to more growth, it could also lead to higher price levels and a weakened dollar. Investors will need to monitor how this plays out–for now, it’s too soon to tell.

Gregg S. Fisher, CFA, CFP, gfisher@gersteinfisher.com, is president and chief investment officer of Gerstein Fisher, an independent financial advisory firm in New York City, www.gersteinfisher.com.